BUSF_A01.qxd

Appendix 4 • Suggested answers to selected problem questions

16.1 Tiny Tim Ltd and Mega plc

Price/earnings ratio =

or:

Market price of a business =Price/earnings ratio ×After-tax earnings of the business

Market price of Tiny Tim Ltd = 16 ×£350 000 =£5.6 million

This needs to be adjusted to take account of the fact that Tiny Tim Ltd is less marketable

than Mega plc. A discount of, say, 25 per cent should be applied, giving an estimated value

of £4 million to £4.5 million for Tiny Tim Ltd.

16.3 PR Industries and Howard Pope Ltd

On the basis of the information provided, the following approaches can be taken to valu-

ing the shares of Howard Pope Ltd (HP Ltd):

(i) Price/earnings basis

Price/earnings ratio =

Market price of a share =Price/earnings ratio ×After-tax earnings per share

Market price of a share of HP Ltd = 15 ×=£5.74

(ii) Dividend growth model basis

According to the Gordon growth model:

Cost of equity =+Growth rate of dividends

or:

Current share price =

Current price of an HP Ltd share ==£4.58

(iii)Net (balance sheet) assets basis

Price per share =

Price of an HP Ltd share ==£2.84

The figures resulting from the use of the first two methods would need to be fairly heav-

ily discounted (say by 25 or 30 per cent) to take account of the fact that the HP Ltd shares

are very unlikely to be easy to sell, HP Ltd being a private company.

£172.22m −£30.00m −£28.80m

2m × 20

Net assets (from the balance sheet)

Number of shares

[£5m/(2m ×20)] ×1.10

0.13 −0.10

Next year’s dividend per share

Cost of equity – Growth rate of dividends

Next year’s dividend per share

Current share price

£15.3m

2m × 20

Market price of a share

After-tax earnings per share

Market price of a business (or single share)

After-tax earnings of the business (or a single share)

Chapter 16

BUSF_Z03.qxd 11/19/08 10:33 Page 498